Longevity Risk Worries Investors

6a017c332c5ecb970b01a3fcbc2c3d970b-320wiEnter Longevity Insurance – But Look Closely Before You Buy.

You name the fear, the financial industry will come up with a solution to sell.

These days, the fear is outliving our money.  Indeed, we are living longer… and all those extra years cost money.

Enter longevity insurance.  Like all financial products, there are good points and others not so good.  It pays examine the pros and cons in light of your own needs before you buy.

First, what it is:   Longevity insurance is generally nothing more than a single premium deferred annuity with a specified start date for making payments.   For example: A 65 year-old can purchase an annuity today; but the annuity doesn’t begin making payments until age 85. Once payments begin, they continue for life.

Why insurance companies can do it:  Insurance companies know that because the life expectancy of a typical 65 year-old Caucasian woman is about 20 years, about half likely won’t live to collect and about half will.  Those that do will diminish in numbers as each year passes.

But, it’s not all roses.  It pays to know what you’re buying.

Longevity insurance is generally nothing more than a single premium deferred annuity with a specified start date for making payments.   For example:  A 65 year-old can purchase an annuity today; but the annuity doesn’t begin making payments until age 85.  Once payments begin, they continue for life.

Of course, insurance companies know that because the life expectancy of a typical 65 year-old Caucasian woman is about 20 years, about half likely won’t live to collect and about half will.

It should come as no surprise that the payouts on longevity insurance are higher than what a purchaser would receive for a normal annuity.  The reasons are simple:  (1) about half will never collect, as stated above, (2) those who do collect – the other half – will be fewer and fewer as the years progress, and (3) the insurance company has many years to invest the money between the date of purchase and the date that payments begin – in our example, 20 years!

The good news:  Longevity insurance allows retirees to plan for their later years with greater certainty.  As most planners will tell you, it’s the second and third decade of retirement that can be the most dicey because of taxes and inflation.

There are some limitations, however, worth noting:

  • Inflation will reduce the purchasing power of future payments.  What may sound like a good payout today may not be so good when the day comes.
  • The after-tax value of those payments may be reduced if/when tax rates increase.  Because of the fixed cash flow, it will be hard to do tax planning with that income.
  • The purchaser does lose control over whatever portion of the retirement portfolio that is used to contribute to the annuity.  That money can’t be independently invested or easily accessed if Murphy’s Law happens.  An annuity, after all, is basically an insurance company I.O.U. and the money is in the company’s control.

There is pending legislation that would allow taxpayers to purchase longevity insurance inside retirement accounts (Reg 115809-11) and also allow taxpayers over age 70-1/2 who hold those annuities in those accounts to exclude their value when calculating their required minimum distributions (RMDs).

Jim